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Strait to market

It is rare to see a Taiwanese company setting records in mainland China’s capital markets, but such is the case with Foxconn Industrial Internet (FII).

Terry Gou’s company is about to launch the largest IPO of the past three years – Rmb27.13 billion ($4.23 billion) – after an exceptionally speedy approval process (a mere five weeks compared to the more typical wait of a year or two).

Gou is also helping to pioneer reforms across the country’s equity capital markets.

As we wrote in WiC404, FII represents just the kind of tech play that Chinese regulators want to entice away from the bourses of Hong Kong, New York and Taipei.

Then again, while China’s IPO market is open again, some analysts think that a flow of 200-odd new listings is weighing on secondary markets at a time when global indices are also under pressure. In the year-to-Thursday’s close, for example, the Shanghai Composite Index is down 6.4%, one of Asia’s worst-performing stock indices.

However, though secondary markets have been getting progressively weaker, it has not dampened demand for FII’s flotation. The public tranche closed more than 711 times oversubscribed – not that surprising given the deal is being executed below the regulator’s price-to-earnings cap of 23 times.

At Rmb13.77 per share, the share offering has been priced substantially lower at 17.2 times last year’s earnings. This valuation is higher than Gou’s Taiwanese-listed Hon Hai Precision Industries, which owns 94% of FII and is trading around 11 times 2017 earnings. But it is below A-share listed peers such as Han’s Laser and Zhejiang Dahua Technology, which are both trading in the mid-20s on a 2017 earnings basis.

It means FII is almost certain to trade up once it lists, underscoring the old saying that getting allocation of IPO shares in China is akin to winning the lottery.

The country’s retail-centric IPOs are typically volatile once they hit the secondary market as well, with individual investors cashing out quickly to lock in their upside.

Foxconn, however, has adopted a syndicate policy, which is far more in line with Hong Kong precedent. In recent years, big Hong Kong IPOs have increasingly relied on larger cornerstone tranches – hefty allocations to strategic investors, who hold onto their shares for a minimum period (in FII’s case, three years). The practice is not without its critics. Although cornerstone tranches can help to get IPOs fully funded, they reduce after-market liquidity and can lead to mispricing, due to a heavy preponderance of ‘friends and family’ investors who tend to be less fussy about valuations than traditional institutional investors.

Foxconn has placed 30% of its latest deal with cornerstones. These number three big state investment funds (including Central Huijin) as well as the BAT internet troika (Baidu, Alibaba, Tencent).

The BAT’s participation has attracted plenty of headlines as it is rare to see all three participate in the same IPO, although they are all moving into a sector where FII plans to have an edge.

FII is being described as a pioneer of the industrial internet at a time when the Foxconn Group wants to move away from contract manufacturing (principally making lots of iPhones for Apple) to ‘smarter’ business (providing all manner of AI and Big Data-related services and parts).

Information in FII’s prospectus shows that this is a road still to be travelled (its revenues are primarily derived from the manufacturing of casings for iPhones, networking equipment and servers, rather than sales of more advanced equipment and robots).

But at least these businesses enjoy higher gross profit margins than their parent (10% vs 6.4%) and CICC, the company’s IPO sponsor says that FII should be one of the principal beneficiaries of a wave of manufacturing upgrades over the coming decade.

The plan is that it will join other companies in tapping into the industrial internet as a key part of the government’s longer term vision “to incorporate new technologies such as AI and Big Data into its manufacturing sector,” says CICC.

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